The advice arrives quickly and from everywhere. Start earning on the side, and within a week somebody will tell you to form an LLC, usually with the implication that it will save you tax.
It will not. A single-member LLC changes nothing about what you owe, and for most people starting out it is a cost and an annual filing in exchange for a protection they could get more cheaply elsewhere.
There are real reasons to form one. Tax is not among them, at least not until you are earning considerably more than a side hustle usually earns.
You already have a business
You did not need to do anything to start one.
Sell something, do paid work for someone, earn advertising revenue, and you are a sole proprietor. There is no form and no fee. You report the income on Schedule C attached to your ordinary tax return, you deduct your business expenses there, and you pay self-employment tax on the profit.
You can do all of that under your own name. You can open a business bank account, take on clients, sign contracts and deduct every legitimate expense without registering anything with anybody.
Which means the question is never whether to have a business. It is whether to put a company between you and it.
An LLC does not change your tax
A single-member LLC is what the IRS calls a disregarded entity. For tax purposes it is not there. You file the same Schedule C, on the same personal return, and you pay the same income tax and the same 15.3% self-employment tax on the same profit.
Same deductions, too. A sole proprietor deducts the home office, the mileage, the software and the phone line exactly as an LLC does. Nothing becomes deductible because a company owns it, and no expense is disallowed for want of one.
If somebody has told you an LLC will cut your tax bill, they were either thinking of the S corporation election, which is a separate decision covered below, or they were repeating something they heard.
What limited liability protects, and what it does not
An LLC provides limited liability. If the business is sued or cannot pay its debts, the claim is against the company's assets rather than your house and savings.
That is a genuine protection and it is worth having when there is something to protect against. It comes with three limits people rarely hear about.
It does not cover your own actions. If you personally do the negligent thing, you can be sued personally. An LLC does not put a wall between you and your own professional work, which is precisely the risk most freelancers actually carry.
It collapses if you treat it casually. Run business money through your personal account, pay for groceries from the business card, keep no separation, and a court can disregard the company entirely. Maintaining the protection means maintaining the separation, permanently.
Lenders ask you to waive it. Any bank lending to a new small company will want a personal guarantee, which puts you back on the hook for the one debt most likely to matter.
What it costs
Formation is usually somewhere between $50 and $500 depending on the state. That is the part everybody quotes, and it is the smaller half.
The recurring costs are what to plan for. Most states charge an annual report or franchise fee. California's minimum franchise tax is $800 a year regardless of whether the business made a penny, which has ended a lot of small side businesses that were never going to clear it. A registered agent, if you do not want your home address on a public record, is typically $100 to $300 a year.
Then the running of it: a separate bank account, and separation maintained properly, because a casually run LLC is an expense without the protection it was bought for.
For a side business making $6,000 a year, that arithmetic rarely works.
The S corporation election
There is a real tax play here. It is the S corporation election, and it is a different thing from forming an LLC, though it usually requires one.
An LLC can elect to be taxed as an S corporation. You then become an employee of your own company, pay yourself a reasonable salary, and take the remaining profit as a distribution. Payroll taxes apply to the salary. They do not apply to the distribution.
On $100,000 of profit with a $60,000 salary, the $40,000 distribution escapes the 15.3%, which is around $6,000. Real money.
Four things stop this being free.
Reasonable is a legal standard, not a preference. Pay yourself $20,000 on $150,000 of profit and you are inviting an argument you will lose, with back taxes and penalties.
You have to run payroll. Filings, deposits, W-2s, usually a payroll service. Several hundred to a couple of thousand a year.
A separate return. Form 1120-S, and the accountant who prepares it.
A lower salary means lower Social Security credit, and it can shrink what you are allowed to contribute to a retirement plan, which for some people cancels the saving entirely.
The rough consensus is that the arithmetic starts working somewhere above $40,000 to $50,000 of net profit, and is clearly worth it well above that. Below it, the costs eat the saving.
When to form one early
Six situations where the answer is yes regardless of profit.
Physical risk. People come to your premises, you make something that could injure someone, you work in their homes.
Employees or contractors. You become responsible for what other people do.
A partner. Two people in business together without an entity is a general partnership, where you are personally liable for what your partner does. That is worth fixing on day one.
Clients who require it. Some companies will not contract with a sole proprietor. This is a business reason rather than a legal one and it is a perfectly good reason.
Meaningful debts or leases in the business's name.
Property. Rental property is the classic case, and the liability is real and large.
What most of the list has in common is a third party who could be harmed. Writing, design, tutoring and consulting from a laptop mostly do not have that, which is why most people writing online do not need one in year one.
Two things worth doing instead
Buy insurance. General liability, or professional indemnity for advice-based work, often costs a few hundred a year and covers the thing an LLC does not: your own mistakes. For most freelancers it is the better first purchase, and it pays legal costs rather than merely limiting who can be sued.
Get an EIN. It is free, it takes ten minutes on the IRS website, and you do not need any kind of company to have one. Its practical use is that you put it on the W-9 forms clients ask you to complete, instead of your Social Security number. Handing your SSN to every client you work for is a quiet risk that costs nothing to remove.
The short version
Start as a sole proprietor. Keep a separate bank account and clean records from the first payment, because that habit is what makes everything later easy. Get an EIN so your Social Security number stays private. Buy insurance if your work could harm anybody.
Form an LLC when there is a liability worth limiting, a partner, or a client who insists. Consider the S corporation election when profit is consistently above roughly $50,000, and take advice at that point rather than acting on a video.
The order matters. People do it backwards, forming a company for a business that has not proved it will make money, and pay a franchise fee for three years on a side project that earned $400.
Where this fits with everything else
For what you actually owe as a sole proprietor, with a calculator for what stays in your account, see side hustle taxes. For when it has to be paid, quarterly estimated taxes.
For sheltering the profit once there is some, Solo 401(k) or SEP IRA for side income covers accounts that need no company at all.
And if you are still choosing the work itself, 25 ways to earn money from home and online covers the options.
Sources
How a single-member LLC is treated for tax is set out in the IRS page on single member limited liability companies. The S corporation election and the reasonable compensation requirement are covered in the IRS guidance for S corporation shareholders and officers.
Frequently asked questions
Do I need an LLC for a side hustle?
Usually not at first. You are already a sole proprietor and can deduct expenses and open a business account without one. Form an LLC when there is a real liability to limit, a business partner, or a client that requires it.
Will an LLC lower my taxes?
No. A single-member LLC is disregarded for tax, so you file the same Schedule C and pay the same income tax and self-employment tax. The saving people are thinking of comes from the S corporation election, which is a separate choice with its own costs.
At what income does an S corp election make sense?
Somewhere above roughly $40,000 to $50,000 of net profit, once payroll and an extra tax return are paid for. Below that the costs usually exceed the saving, and it is worth an accountant's view rather than a rule of thumb.
Can I deduct expenses without an LLC?
Yes, fully. Business deductions belong to the business activity, not to a legal entity. A sole proprietor claims the home office, mileage, software and everything else on Schedule C.
Do I need an EIN?
Not legally, as a sole proprietor with no employees. It is worth getting anyway, because it goes on client W-9 forms in place of your Social Security number. It is free from the IRS and takes about ten minutes.
Does an LLC protect me if a client sues over my work?
Often not. You can be held personally liable for your own negligent acts regardless of the entity. Professional indemnity insurance covers that risk, which is why insurance is frequently the better purchase for freelancers.
What does an LLC cost to keep?
Formation is typically $50 to $500, then an annual state fee that varies widely. California charges a minimum $800 franchise tax whatever you earn. Add a registered agent at $100 to $300 a year if you would rather not publish your home address.